CH 2

Question 1

What are financial markets traditionally segmented into?

Answer 1

Money markets and capital markets.

Question 2

What financial instruments are included in “money markets”?

Answer 2

Short-term, marketable, liquid, low-risk debt securities.

Question 3

What financial instruments are included in “Capital markets”?

Answer 3

Long-term and higher risk (when compared to money market) securities.

Question 4

What segments can Capital markets be subdivided into?

Answer 4

• Longer-term debt markets
• Equity markets
• Derivative markets (where options and futures are traded in)

Question 5

What specific securities constitute under “Money markets”?

Answer 5

• Treasury Bills
• Certificates of deposit
• Commercial paper
• Bankers’ acceptances
• Eurodollars
• Repos and reserves
• Federal funds
• Brokers’ calls

Question 6

What specific securities constitute under “The bond market”?

Answer 6

• Treasury bonds and notes
• Federal agency debt
• Municipal bonds
• Corporate bonds
• Mortgage-backed securities

Question 7

What specific securities constitute under “Equity markets”?

Answer 7

• Common stocks

* Preferred stocks

Question 8

What specific securities constitute under “Derivative markets”?

Answer 8

• Options
• Futures and forwards
• Swaps

Question 9

What specific securities constitute under “Indexes”?

Answer 9

• Dow Jones averages
• Standard & Poor’s indexes
• Bond market indicators
• International indexes

Question 10

Define “commercial paper”.

Answer 10

Short-term unsecured debt issued by large corporations.

Question 11

Define “banker’s acceptance”.

Answer 11

An order to a bank by a customer to pay a sum of money at a future date.

Question 12

Define “Eurodollars”.

Answer 12

Dollar-denominated deposits at foreign banks or foreign branches of American banks.

Question 13

Define “repurchase agreements (repos)”.

Answer 13

Short-term sales of securities with an agreement to repurchase the securities at a higher price.

The securities are often of higher value than the purchase price paid, and act as collateral if the borrower defaults.

Question 14

Define a “Eurobond”.

Answer 14

A bond denominated in a currency other than that of the country within it is issued.

Question 15

Define “municipal bonds”.

Answer 15

Tax-exempt bonds issued by state or local governments.

Question 16

Describe the two types of municipal bonds there are.

Answer 16

1) General obligation bonds:

municipal bonds backed by credit (taxing power) of the issuer.

2) Revenue bonds:

Municipal bonds backed by the revenues from a given project or by the municipal agency operating the project.

Question 17

What is the yield ratio for municipal bonds?

Answer 17

r[muni] / r[taxable] = Yield ratio

Question 18

What mathematical inequalities of the yield ratio determine whether you hold taxable debt or municipal debt?

Answer 18

1 > Yield ratio > 0 : Investors hold taxable debt

Yield ratio > 1 : Investors hold municipal debt

NOTE: Yield ratio = r[muni] / r[taxable]

Question 19

Define “Callable bonds”.

Answer 19

Bonds that give the firm the option to repurchase the bond from the holder at a stipulated call price.

Question 20

Define “Convertible bonds”.

Answer 20

They give the bond holder the option to convert each both into a stipulated number of shares of stock.

Question 21

Define “preferred stock”.

Answer 21

Nonvoting shares in a corporation, usually paying a fixed stream of dividends.

Question 22

What is a ‘Line of credit’?

Answer 22

Best described with an example:

• Take a line of credit loan of 10K
• you can withdraw up to a minimum amount of 10K, however if you only withdraw for example 2K, you will only be charged interest on the 2K you took out.

A line of credit is essentially a safety net.